New IRS Guidance Clarifies that Forgiven PPP Costs are Not Deductible

On April 30, 2020, the IRS released Notice 2020-32, providing further guidance on the deductibility of certain otherwise deductible expenses for federal income tax purposes. Specifically, the notice clarifies that no deduction is allowed under the Internal Revenue Code (“IRC”) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the CARES Act.

In other words, allowable expenses under the Paycheck Protection Program (“PPP”) such as payroll costs, mortgage interest, rent, and utilities will not be deductible for federal tax purposes to the extent of the resulting PPP forgiveness, since such payment is allocable to tax-exempt income. Section 265(a) of the IRC disallows a deduction for amounts that are otherwise deductible if the amounts are allocable to one or more classes of tax-exempt income. The IRS has concluded that the CARES Act exclusion from income for forgiven PPP loan amounts results in a “class of exempt income” and the otherwise deductible expenses are thus disallowed under IRC Section 265(a).

Remember, one of the most attractive features of the PPP loan was the potential for forgiveness on a tax-free basis. While the IRS has maintained their position on forgiveness excludable from taxable income, the disallowance of the PPP expenses has essentially put the taxpayer back into a “net zero” position for tax purposes. The bottom line for taxpayers is this Notice confirms they would have been in the same position had the IRS chosen to tax the forgiveness income and allow the deductions in the first place. 

If you need any clarification on the details of PPP loans or other provisions of the CARES Act, please contact your CironeFriedberg professional.